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Buy, Sell, or Hold: McMoRan Exploration

Does the great potential here outweigh the risks?

When considering any stock for your portfolio, don't be swayed by just the positives. Examine its pros and cons, and decide whether it's possible upside outweighs its risks. Let's take a look at oil-and-gas explorer and developer McMoRan Exploration(NYSE: MMR) today and see why you might want to buy, sell, or hold it.

McMoRan Exploration is fairly small, with a market capitalization of about $2 billion. Founded in 1994 and based in New Orleans, it seeks and finds oil and natural gas, primarily in the Gulf Coast region of America, as well as in the Gulf of Mexico. As of last Dec. 31, its proven oil and natural gas reserves totaled 255.8 billion cubic feet equivalent.

BuyA big reason to consider buying into the company is its industry. Despite the ongoing growth of alternative energy, oil and gas are likely to remain in demand for quite some time.

Another factor that appeals to some investors is this: McMoRan Exploration does a lot of business with Chevron(NYSE: CVX), and some speculate that Chevron may just buy the company outright one day. Such transactions typically are done at a premium to the going price of a stock, so shareholders can experience a nice bump. Still, the acquisition remains just speculation, and some buyouts don't offer much of a premium. Even if they do, when a smaller, faster-growing company is bought by a bigger, slower-growing one, shareholders can end up with less exciting growth prospects. It can be more powerful for a portfolio if a company succeeds and grows briskly on its own.

One exciting possibility for the company is its majority stake in a promising Davy Jones well in the Gulf of Mexico. The company cites great potential in the Davy Jones field, but has yet to realize it. It's true that it could run out of money before it succeeds there, but the company's balance sheet is stronger than those of many peers, so it's not in imminent danger.

SellOne reason to consider selling the stock, or avoiding it, is the low price of natural gas, which has been putting pressure on many energy companies. A supply glut has kept prices down and motivated natural gas drillers to cut back on production, and the low price of gas has made oil less attractive as a fuel. (Some Fools see the glut shrinking soon, though.) Companies cutting back on production include ExxonMobil(NYSE: XOM) and EnCana(NYSE: ECA). Some other companies, such as Ultra Petroleum(NYSE: UPL), though, have locked in higher prices through hedging. They have an incentive to keep producing.

If you're looking for profitability in the companies in which you invest, look elsewhere. McMoRan has been reporting net losses, not gains, in recent years (mostly) -- though those losses have been shrinking, and net gains may be around the corner. Free cash flow has been growing in the wrong direction, though, to some degree because of increases in spending on property, plants, and equipment.

McMoRan's recent quarter was disappointing, with the company pointing to pipeline repairs, shipping delays, and declining gas sales.

Another negative for the company is its soaring share count. Companies will often raise money by issuing more shares, but doing so dilutes the value of the existing shares. (Imagine hearing that the pizza you'll be getting a slice of will be cut into 12 pieces, instead of the eight pieces you were expecting.) McMoRan's share count has gone from about 34 million in 2007 to roughly 161 million recently.

Hold (or hold off)Given the reasons to buy or sell McMoRan Exploration, it's not unreasonable to decide to just hold off. You might want to wait for the company to post a string of profits, for example, or for the price of natural gas to rise significantly, or for the Davy Jones well to start delivering.

The verdictI'm holding off on McMoRan Exploration for now. It may perform spectacularly in the coming years, but there are plenty of compelling stocks out there. Everyone's investment calculations are different, though. Do your own digging and see what you think.

Meanwhile, if you like energy stocks, we have another stock you should look at more closely. Read about it in The Motley Fool's special free report on the energy industry and its best prospects. It's free, but available only for a limited time.

Author

Selena Maranjian has been writing for the Fool since 1996 and covers basic investing and personal finance topics. She also prepares the Fool's syndicated newspaper column and has written or co-written a number of Fool books. For more financial and non-financial fare (as well as silly things), follow her on Twitter... Follow @SelenaMaranjian